How Much is Too Much?

Maybe you’ve seen this or not, however, my favourite resource, Merriam-Webster, recently added this new word into their vast dictionary volume.

Now there is a new Finance word in town, and you’ll never guess:

Haircut – yes, we aren’t kidding you, it’s HAIRCUT.

Haircut: a new word was added, meaning “a reduction in the value of an asset.”

Here are some examples Merriam-Webster offer as examples of the new definition:

– El Paso’s shareholders could be all but wiped out, and bondholders could take a big haircut.— William P. Barrett

– Square revealed Friday pricing at $11 to $13 a share for its anticipated IPO, giving the tech company at most a $4.2 billion valuation—at least a 30% haircut from its most recent valuation in the private market.— Todd C. Frankel

– Greece’s finance minister has told lawmakers he sees three scenarios to resolve the debt crisis, including one involving an orderly default with a 50 percent haircut for bondholders, two Greek newspapers reported on Friday. — Reuters

Let’s see if bookkeepers and accountants test their clients’ resolve by using this term. Would you? I think it’s pretty funny and whoever first came up with this metaphor was a little amusing, but a lot lazy. Seriously, haircut as a definition in finance?

Wikipedia defines a haircut as the difference between the market value of an asset used as loan collateral and the value ascribed to that asset when used as collateral for that loan. They also explain it this way, and I quote:

“The amount of the haircut reflects the perceived risk of the asset falling in value or being sold in a fire sale: the larger the risk is perceived to be, the larger the haircut will be. The lender will, however, still hold a lien for the entire value of the asset. In the event the collateral must be sold to repay the loan, theaircut is intended to protect the lender from recovering less than the full value of the outstanding loan amount from sale of that collateral, even allowing for reductions in the market value.”

For example, if you needed a $5,000 loan and wanted to use your $5,000 stock portfolio as collateral, the bank is likely to recognize the $5,000 portfolio as worth only $2,500 in collateral. The $2,500 or 50% reduction in the asset’s value, for collateral purposes, is called the haircut.

It’s lower than market value and is used since the market maker’s spreads are so thin.

And that brings us to another word: spread. No, not peanut butter or margarine, but essentially the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept. That’s a spread alright!

Confused? It used to be called competitive pricing, haggling, or even coming to an agreement. But hey, every industry, including yours, probably has unique buzz words and what you would name internal aspects: deep-dive, outside the box, bleeding edge, you know what I mean. So it’s no surprise the finance industry has some unique buzzwords as well.

Haircut is one cute example! Or is it? A haircut is the difference between buying and selling – that’s simple, right?

My advice: don’t cut too much off!

Have a grand day and if you’re looking for a certified bookkeeper, visit me here and let’s find out what you need for your books. Http://proriskbookkeeping.com